By Michael Mackenzie in New York
The US bond market raised the odds of renewed deflation risk on Thursday, with a key benchmark Treasury yield falling below the current core rate of inflation.
The yield on five-year notes was trading below 1.5 per cent. Last week, data showed that core inflation – which excludes food and energy prices – was running at an annualised rate of 1.5 per cent, up from 0.6 per cent in December, the fastest rise over a six-month period since 1983.
In spite of that jump, the yield on five-year notes fell to 1.44 per cent by mid- afternoon in New York, its lowest level since November. It means that five-year yields are not pricing in any risk premium for inflation, though a measure of core inflation based on personal spending and consumption is running at an annualised rate of 1 per cent.
?I would argue the yield on five-year notes below the core inflation rate of 1.5 per cent is pricing in deflation,? said Richard Gilhooly, strategist at TD Securities.
In remarks on Wednesday, Ben Bernanke, chairman of the Federal Reserve, said purchases of Treasury debt under the policy of quantitative easing, which ends this month, ?have been very successful in eliminating deflation risk?.
Mr Gilhooly said: ?Just as Bernanke is proclaiming deflation risk has gone, the market is arguing the opposite. The only time we have seen this occur is back in late 2008 and early 2009 when the market was worried about deflation and ahead of quantitative easing being introduced.?
The decline in Treasury yields on Thursday came as oil prices tumbled and eurozone debt contagion fears flared again. Uncertainty over the US economic outlook was signalled by Mr Bernanke on Wednesday. Haven buying for Treasuries was underlined by negative rates in the repurchase market on Thursday, indicating a reluctance among holders of Treasuries to lend them out.
Many in the bond marketare thus taking the view that the soft patch in the US economy will result in lower core inflation later this year. William O?Donnell, strategist at TD Securities, said: ?People think core inflation will be throttled back as the US economy faces austerity measures, weaker growth and the unknown consequences of the Greece crisis.?
The market expects inflation to run at 1.8 per cent over the next five years, down from 2.10 per cent late last week and a peak of 2.48 per cent in May.
Paul Ashworth, economist at Capital Economics, said: ?The annual rate of core inflation may peak as high as 2 per cent in the second half of this year, but we then expect it to fall back to around 1 per cent in 2012.?
? The Financial Times Limited 2011
